The War over Taxable Transportation
Business aviation is regulated and watched by an alphabet soup of government agencies—FAA, IRS, DOT, SEC, state authorities and others—that don’t see eye-to-eye on key issues. A January 2015 federal District Court decision illuminates an excellent example: the disagreement between the IRS and FAA over who is providing transportation to whom.
The case, NetJets Large Aircraft, Inc. v. United States, concerns whether NetJets’ fractional-share program and its affiliate, ExecutiveJet Management (EJM) should be collecting federal transportation excise tax. That’s the 7.5 percent levy the IRS charges on amounts paid for “taxable transportation,” which is tacked onto the price of your ticket every time you fly on the airlines.
NetJets, however, isn’t an airline; it offers customers an opportunity to purchase or lease a share of an aircraft that it manages and (in theory) operates. When the IRS scrutinized NetJets in 1992, it decided the program was providing taxable transportation because the shareowners had relinquished to the company “possession, command and control” of their airplanes—the standard used by the IRS for assessing thetax. In other words, NetJets was viewed not as assisting the shareowner to fly on program aircraft, but as actually providing transportation, just like an airline or charter outfit.
NetJets and the IRS agreed that the 7.5 percent tax would be assessed on the occupied hourly fees that shareowners pay every time they fly on the company’s aircraft, but not on the management fee or other charges paid by owners, and certainly not on the purchase price of theshares. But even though NetJets started to collect excise tax on this basis, the company never conceded that any tax was ever owed, and accordingly brought a refund suit against the IRS. A federal Circuit Court decided that case in 1997, concluding that NetJets was “in a business of transporting persons or property by air” and declining to refund the tax.
The 1997 decision, while affirming the tax on the hourly rate, didn’t address the question of whether the tax should also be paid on themanagement fee and other NetJets charges. For its part, the IRS claimed never to have conceded that the tax should be limited to the hourlyfee. As a result, the saga continued in the courts—even after Congress in 2012 made fractional programs (at least temporarily) no longer subject to transportation tax—with the IRS and NetJets arguing about whether the scope of payments subject to tax could be expanded.
The January 2015 court decision attempted to put both these issues to bed. The court granted summary judgment to the IRS on whether NetJets provides taxable transportation (it does, said the court), but also granted summary judgment to NetJets on whether the IRS can tax morethan the hourly rate (it can’t, according to the court).
It would be a mistake, however, to think that the court gave the IRS only half a loaf. True, the court declined to expand the scope of payments that could be taxed, but only because it decided that NetJets had justifiably relied on an agreement with the agency that only the fractional provider’s hourly fee was taxable. (Share programs lacking similar agreements with the IRS may be in trouble, as evidenced by a March 2015 U.S. District Court decision that awarded summary judgment to the IRS regarding imposition of excise tax on Flexjet management fees.) Further, the court not only rejected NetJets’ argument that it wasn’t providing taxable transportation; it also declined to grant summary judgment to either the IRS or EJM on whether EJM provides taxable transportation. The court’s remarks on the latter issue reflect a misunderstanding of how aircraft management companies operate.
Back in 2006–08, the FAA investigated aircraft management company arrangements to see whether such companies, not their clients (the aircraft owners), had “operational control” of aircraft operated under the FAA’s non-commercial Part 91 regulations. Ultimately, the FAA decided that, as long as the agreements between the parties were properly structured, the owners indeed had operational control. In separate modifications to Part 91 in 2003, the agency codified rules for how fractional owners in programs like NetJets could also retain operational control of their aircraft.
In the NetJets case, the program cited these FAA regulatory moves in an attempt to show that both fractional owners and owners of managed aircraft under Part 91 retain “possession, command and control” of their airplanes for tax purposes. The court, however, dismissed NetJets’ argument, describing FAA rules as “safety” regulations that are neither controlling nor even applicable to a tax dispute. “The IRS,” noted the court, “has long considered its application of the tax code independent from the FAA’s safety rules.” In the Flexjet case referred to above, the court cited the NetJets court on this issue with approval.
While technically correct, the court is headed down the wrong road. The FAA’s determination that the owner, not the management company, is the operator of a Part 91 flight isn’t just a legal conclusion; it reflects a host of factual assumptions. That’s because the FAA is really trying to determine who ultimately calls the shots and who should be held responsible for operating a flight, an issue the FAA understands better than the IRS. In taking a contrary position for tax purposes, is the IRS trying to understand what’s really going on, or is it just trying to apply a standard that maximizes tax revenue?
Both agencies recognize that few business jet owners pilot their own aircraft, so they have to employ flight crew. The FAA has concluded that owners don’t abandon operational control when they hire a management company rather than directly employing flight department personnel. Rather than pounding on the table about how it runs its own government department, the IRS should learn from this. Maybe the courts need to as well.
Jeff Wieand is a senior vice president at Boston JetSearch and a member of the National Business Aviation Association’s Tax Committee.